The final years of troublesome pensions

The term of many market-linked pensions held within SMSFs will be coming to an end soon. Mark Ellem details the factors requiring consideration when preparing for the final payments of these income streams.

Considering market-linked pensions (MLP) came into being from 20 September 2004 and could only be commenced from a member’s accumulation interest up until 20 September 2007, many of these pensions are coming to the end of their term. In this technical article we explain the rules governing payments in the final year of the MLP, which are not as straightforward as you might think.

Background MLPs first became available on 20 September 2004. From this date until 20 September 2007, any retiree could commence an MLP in an SMSF.

However, changes introduced by the Simplified Superannuation legislation in 2007 meant that after 20 September 2007 any new pension interest commenced in an SMSF was required to be an account-based pension as defined under Superannuation Industry (Supervision) regulation 1.06(9A). This means a member can no longer commence a new MLP with their accumulation interest in an SMSF. A member may, however, commence a new MLP in an SMSF using the balance rolled over from the commutation of an existing complying pension, for example, a defined benefit pension or another MLP.

Another significant change introduced by the Simplified Superannuation reforms was that MLPs commenced after 20 September 2007 must also satisfy the minimum pension standards for account-based pensions, under schedule 7 to the SIS Regulations, in addition to the market-linked income payment rules, under schedule 8 to the regulations.

Annual MLP payment

MLPs are payable for a fixed term, which is specified at commencement and included in the details of the pension documentation. The member must select a term for the new MLP that is between their minimum and maximum allowable term, the length of which depends on when the pension commenced, the age of the member at that time and whether there is a reversionary beneficiary. Essentially, the term will determine the level of pension payments the member must withdraw each year. The payment factors are designed so that the pension assets are drawn down over the term of the pension.

The amount of the annual pension payment to be paid each year is based on two factors:

• the balance of the MLP at the start of the financial year, and

• the payment factor set out in column 3 of the table in schedule 6 (payments for market-linked income streams) to the SIS Regulations.

In relation to the payment factor, this represents the remaining term of the MLP, as at the start of the financial year, expressed in whole years. Many MLPs, like other pensions, would have a start date of 1 July, meaning the remaining term each year will be a whole number. However, for an MLP that started other than on 1 July, the remaining term is rounded as follows:

• if the commencement day of the MLP is on or after 1 January in a financial year –rounded up to the nearest whole year, or

• if the commencement day of the MLP is on or before 31 December in a financial year – rounded down to the nearest whole year.

The following example illustrates this methodology. Harry commenced an MLP on 1 September 2007. At the time he was aged 66 and the term allowable ranges from a minimum of 17 years to a maximum of 34 years. Harry chose the minimum term of 17 years, meaning the MLP will end on 31 August 2024.

For the 2023 financial year, the required pension payment is based on the remaining term, calculated on 1 July 2022. The remaining term at 1 July 2022 is two years and two months and as the MLP commenced before 31 December, the remaining term is rounded down to the nearest whole year, two years. The relevant payment factor from schedule 6 is 1.90.

The other relevant factor is the balance of Harry’s MLP at 1 July 2022, which was $285,650, providing an annual pension payment amount of $150,340 (rounded to the nearest $10 as per Schedule 6 to the SIS Regulations) for the 2022 financial year. The MLP provisions allow for Harry to take an annual pension amount up to 110 per cent of the calculated amount, being $165,374 or as low as $67,653, 45 per cent of the calculated annual pension amount. Harry decides to take an annual pension amount of $105,000 for 2021/22, keeping him below the defined benefit income cap of $106,250. This amount is paid to him as one lump sum on 30 June 2023.

Let’s now move to the 2024 financial year where the balance of Harry’s MLP at 30 June 2023 is $189,220. At that date the remaining term is one year two months, again rounded down to one year. The relevant payment factor from column 3 in schedule 6 is 1, meaning the annual pension payment for 2023/24 is $189,220, with a range from $170,298 to $208,142.

Even though Harry has a range to select his annual payment from, it will be subject to the available account balance, which will be dependent upon the timing of pension payments and the net earnings allocated to his MLP. That is, he could not request an annual pension payment of the maximum $208,142 if there is a lesser amount standing to the balance of his MLP.

Harry takes the minimum pension amount of $170,298 to minimise the amount he will need to include as assessable income in his personal tax return. As with previous years, he takes the amount as a lump sum on 30 June 2024.

Final-year MLP payment

Harry’s MLP is set to end on 31 August 2024 and requires him and his accountant/ administrator to be aware of what rules need to be complied with in this final period of the pension. Harry will need to be paid the final amount of his pension within 28 days after

the end of the term of the MLP, that is, by no later than 28 September 2024. This will require Harry and his SMSF’s accountant/ administrator to be aware of the balance of his MLP at 1 July 2024 and be able to keep track of pension payments and earnings to ensure the MLP is fully paid by 28 September 2024.

The accountant for Harry’s SMSF calculates the balance of his MLP at 30 June 2024 to be $85,166 on 25 August 2024. The SMSF trustees resolve to declare an interim annual earning rate of 3 per cent for the period 1 July 2024 to 25 August 2024 to be applied to Harry’s MLP. An amount of $85,553 is paid to Harry on 26 August 2024 as his final pension payment in respect of his MLP.

The effect of when the MLP term ends

Let’s consider that Harry commenced his MLP on 1 April 2007, was still aged 66 at the time and chose the minimum term of 17 years. This means his MLP will end on 1 April 2024.

For the 2023 financial year, the remaining term is one year and nine months. As the pension commenced on or after 1 January in a financial year, this is rounded up to two whole years for the purpose of identifying the relevant payment factor from column 3 of the table in Schedule 6 to the SIS Regulations. The payment factor is 1.90, which using a balance of the MLP at 30 June 2022 of $285,650, provides an MLP payment range for 2022/23 of $67,653 to $165,374.

Again, Harry takes an annual pension payment of $105,000 as a single lump sum payment on 30 June 2023. The balance of his MLP on 30 June 2023 is $189,220.

The 2024 income year is the final year for Harry’s MLP as the term ends on 31 March 2024. It would be expected the MLP would need to be fully extinguished by 28 April 2024, being within 28 days after the end of the term of the MLP. However, the rules allow for an alternative period to be chosen where on 1 July of the current financial year:

• the payment factor that applies is 1.00, and

• the payment factor that applied for the previous financial year was not 1.00.

Where the above applies and the choice is made, payments made in respect of the current financial year and the period after, if any, are in accordance with the payment requirement if they comply with the following conditions:

a. Payment of the account balance over one of the following periods: i. if the remaining term of the MLP is greater than 12 months – that period, ii. 12 months,

b. the fund has no further obligation to make any other payment that, but for this alternative, would have been determined on 1 July in the subsequent financial year. Applying this to Harry’s MLP:

• the payment factor relevant for the current 2024 financial year is 1.00,

• the payment factor relevant for the prior 2023 financial year was not 1.00, it was 1.90,

• the remaining term of the MLP on 1 July 2023 is not greater than 12 months. Consequently, the relevant period is 12 months.

Therefore, in the final 2024 financial year of Harry’s MLP, which ends on 1 April 2024, the balance of his MLP must be paid:

• within 28 days after the end of the term of the MLP, that is, 28 April 2024, or

• if chosen to apply the alternative period, by 30 June 2024.

Again, Harry and his SMSF’s accountant/ administrator will need to be aware of the ending of his MLP to ensure the balance can be monitored to guarantee the relevant rules are complied with in the final year of the pension.

Let’s finally consider if Harry’s MLP was commenced, like many, at the start of a financial year, on 1 July 2007. The term selected by Harry was 17 years and consequently it ends on 30 June 2024.

For the 2023 financial year the relevant payment factor is 1.90 as there are two years remaining. For the 2024 financial year the relevant payment factor is 1.00, as there is

one year remaining. Applying the rules for payment in the final year of the MLP, the balance of Harry’s MLP in the 2024 final year must be paid by no later than 28 July 2024, being 28 days after the end of the MLP. While the alternative period could be chosen, it would have an earlier payment deadline of 30 June 2024.

Considering the MLP payment rules, the following general rule can be applied:

• for an MLP that commenced from 1 July to 31 December or in the month of June, the balance of the MLP must be paid out within 28 days of the end of the MLP, and

• for an MLP that commenced from 1 January to 30 May, the balance of the MLP must be paid out by 30 June of the financial year in which the MLP ends.

Again, given many MLPs may be coming towards the end of their term, accountants, administrators and advisers need to be monitoring their SMSF client base for members with these pensions to ensure the MLP pension standards are complied with. Of course, the member, in this case Harry, would have the option to fully commute his MLP and start a new MLP with a term that effectively extends it beyond the original end date, but that’s a subject for a different discussion.